Bargains in the Energy Patch

The market started the trading week Monday with 300-point intraday reversal spurred by the dysfunctional election results in Italy, which is the third-largest economy in Europe as well as the third-largest debtor nation in the world. The U.S. stock market suffered its largest decline since right after our election in November. I believe this is more confirmation that the market is in a fragile state. I continue to expect an overall 5% to 8% pullback in the markets, but not a major correction. In Monday's column, I outlined three blue-chip positions I plan to add to if that projected selloff indeed comes to fruition.

Today, let's look at a couple of smaller firms I own in the oil & gas sector that I will also add to if equities continue to decline. The sector is one of the few unequivocal success stories of the past five years on the back of an impressive and continuing domestic energy production boom. This expansion is still in its early innings, so there is a lot growth in front of the individual companies in the industry. Here are a couple of picks from the fast-growing energy patch that should continue to expand regardless what the overall market does. Both are cheap compared to their growth prospects and I could see either one eventually being an acquisition target if M&A activity remains robust.

Oasis Petroleum (OAS) is an independent exploration and production company with oil and natural gas resources in the Montana and North Dakota regions of the Williston Basin. The company released quarterly earnings Monday that beat expectations on both the top and the bottom line. It was the third-straight quarter that earnings beat estimates. In addition, consensus estimates for earnings in 2013 had already moved up over the last couple of months and I would expect the consensus to continue to rise after these results. The company more than doubled revenues in 2012 and analysts expect another 50% sales increase in 2013. Given these growth prospects, a forward price-earnings ratio of less than 15 seems cheap with the stock selling at $35 a share. I plan to add to my position if a market pullback brings shares below $33.

Kodiak Oil & Gas (KOG) is an independent energy producer with oil and natural gas reserves and operations primarily in the Williston Basin of North Dakota and Montana, and the Green River Basin of Wyoming and Colorado. After more than tripling revenues 2012, analysts expect the company to double sales in 2013. The company has seen operating cash flow explode in the last few years, going from approximately $10 million in 2009 and 2010 to more than $150 million the in past 12 months. The shares are already cheap at just over 12x this year's expected earnings. The stock is hovering at just under $9 a share and I would be happy to add to my position if the shares reached $8.